When you start a business, you must decide which trading structure (also known as a “vehicle”) is appropriate for you. Indeed, business owners should review the structure of their business at key points in its lifecycle. A structure which was right for a start-up may not suit when the business develops, and becomes more complex.
In this introductory guide, we explain the key features of the most common trading structures, being:
- a self-employed sole trader;
- a partnership;
- an LLP; and
- a limited company.
If you would like more information on the tax and non-tax advantages and disadvantages of incorporation v sole trader status, take a look at our separate Insight post on this subject.
Introduction
There are three business structures, which are commonly used in the UK:
- a sole trade;
- partnerships; and
- companies.
There are different types of both partnership and company.
1. A sole trade
A sole trade consists of one person, who is in business on his/her own account. As a sole trader, you are commonly referred to as being self-employed.
Key features:
- The business and its owner are one legal entity. You are the business.
- This is a very simple and flexible way to trade. There are more sole traders than any other business vehicle in the UK.
- A sole trader is personally liable for all the debts of the business. Your personal assets are at risk. If the business fails, you may go bankrupt.
- All the profits of the business are taxed, as if they are the personal income of the sole trader. You therefore pay income tax and Class 4 and 2 NICs on your business profits.
- A sole trader may employ staff. But you cannot be an employee of the business (i.e. you can’t employ yourself). You are therefore not subject to any form of employment taxes on the sole trade business profits.
- A sole trader cannot rent his/her own property to the business. You and your business are one and the same (i.e. you cannot charge yourself rent).
- If the business makes losses, these losses can be offset against your other income (if you have any). However, this sideways loss relief is subject to restrictions.
- As a sole trader, you are only able to offer security to a lender or own land and property in your name (i.e. personally).
- There is no requirement to prepare annual business accounts in a set format, prescribed by the law. Your business accounts are not on public record.
- You only prepare business accounts for your own needs and for your self-assessment tax return.
- When you start a sole trade business, you must notify HMRC within a set timeframe.
2. Partnerships
A partnership is when two or more persons carry on a business with a view to making a profit. There are various types of partnership, which are governed by different Partnership Acts.
Certain entities are not able to form partnerships, being:
- charities; and
- not-for profit organisations.
Partnerships are based upon relationships, which of course may break down. It is therefore advisable that you create a partnership agreement, to establish the following key terms for administering the partnership:
- profit share;
- capital contributions;
- rules/procedures for new and departing partners;
- succession and death of a partner; and
- divorce of a partner (e.g. if you are income shifting).
There are four different types of partnership
- the conventional (or general) partnership;
- the limited liability partnership (LLP);
- the limited partnership; and
- the Scottish limited partnership.
The conventional partnership
This is governed by the 1890 Partnership Act. This form of partnership has many similarities to a sole trade.
Key features include:
- A partnership is made up of two or more partners. This may include company partners.
- Partners have joint and several liability for partnership debts (i.e. partners are responsible for each other’s debts).
- Partners are taxed on all the profits, although their share of the profits will vary by agreement. Partners pay income tax and Class 2 and 4 NICs on their share of the profits.
However, there are some significant differences to a sole trade:
- If the partnership makes a loss, those partners who do not fully participate in the business may be restricted from claiming sideways loss relief (offsetting losses against other income).
- Partnerships can grant a fixed charge over partnership assets.
- Individual partners may rent property to the partnership for use in the business, and charge it rent.
The limited liability partnership (LLP)
This trading vehicle is a hybrid of a conventional partnership and a company.
LLPs are governed by the 2000 Limited Liability Partnership Act and the Companies Act 2006.
Key features:
- An LLP is a separate legal entity to its members (the partners).
- LLPs have designated partners, who are the equivalent to company officers.
- LLP accounts must be filed with Companies House. LLP accounts are therefore on public record.
- Partners have limited liability unless: (a) the LLP becomes insolvent, and the partners knowingly allowed this to happen. In which case, they may be required to repay their profits of the previous two years; and (b) a partner is found to be at fault at a time when he was acting under his own personal capacity.
- An LLP is taxed, as if it were a conventional partnership (see above).
- Losses are restricted in proportion to each partner’s capital contribution.
- LLPs are subject to substantial tax anti-avoidance legislation.
The limited partnership and the Scottish limited partnership
These limited partnerships are popular when structuring a private equity and investment fund, but they are not suitable if you are looking for a flexible trading vehicle.
3. Companies
There are two main types of company in the UK:
- a private company: and
- a public company.
A private company can be unlimited, limited by shares or limited by guarantee.
Unlimited companies and companies limited by guarantee are mainly used for activities, which have little or no commercial risk or are run as non-profit making/charitable companies.
A private company limited by shares
This is the most common form of company in the UK.
Key features:
- A company is a separate legal entity to its owners (its shareholders) and its directors.
- A company can have one or more shareholders and one or more directors.
- A company has an authorised share capital. Shareholders invest in the company by buying its shares.
- A company is run and managed by its board of directors.
- A company secretary is required to maintain the company’s statutory records.
- A company may be a “single shareholder” company, owned by one individual who is both its director and company secretary.
- A company pays corporation tax on its profits.
- Shareholders are only taxed, when the company distributes its profits to them (for example pays dividends on shares).
- A director is an office holder. This does not automatically make a director an employee in terms of employment law, the national minimum wage or for tax credits.
- A director is treated as an employee for tax purposes when it comes to remuneration received for services provided to the company. He/She will be subject to PAYE income tax and NICs on such income (e.g. salary and taxable benefits in kind).
- In the event of a company’s insolvency, the shareholders will generally find that their shares have no value – they lose the capital that they have invested in them.
- If the company fails, shareholders’ liability is limited to the amount (if any) of unpaid share capital, unless they have given a personal guarantee for the company’s borrowings (which is often required by lenders).
- As a director, you can be held personally responsible, if you continue to trade when your company is insolvent, and this results in financial loss to others. This could result in your personal bankruptcy.
- In the event of a legal dispute, the company will be sued. It is very difficult under UK law to sue a director personally for a company’s actions. There are exceptions most notably where the director has committed fraud and corporate manslaughter.
If there is more than one shareholder/director, it is advisable to consider the need for:
- a shareholders’ agreement; and
- director service contracts.
Public limited company (PLC)
A public company or PLC is set up in a similar way to a private limited company, except that it is permitted to apply for listing of its shares on a recognised stock exchange, and to offer its shares to the public to raise finance. As a result, PLCs are subject to more regulation than private companies, including corporate governance regulations and listing rules.
Every person, every business is different. If you would like to discuss your business and the different structures available to you, we’d love to help. Please do get in touch for a no-obligation conversation – see our Contact Us page for how to reach us.
Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Whyatt Accountancy accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material.